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State lawmakers are exploring the idea of paying back more than $2 billion in federal debt for unemployment insurance by issuing tax-exempt bonds.

It’s a move Texas made and several states are considering in hopes of capturing lower interest rates than what the federal government is offering. That would help cut the expense on businesses, which must foot the bill for the massive debt.

It’s too preliminary to say how much Indiana could save by bonding, but officials in Texas estimate savings of $100 million on their $2 billion in bonds issued late last year.

But while the benefits could be big, Indiana officials are taking their time to dissect the concept.

Tallian

Sen. Karen Tallian, D-Portage, has offered a bill that would give the state’s debt-issuing arm power to investigate whether bonding is the most cost-effective way to pay off the debt. If the Indiana Finance Authority determines it is, the agency could draft a proposal to issue bonds but would need additional legislative approval before moving forward.

Republicans, who control the House and Senate, also have been in recent discussions about the idea, but any action would come with caveats.

Hershman

“We will not mandate bonding as a solution to the repayment of federal debt at this time,” said Brandt Hershman, the Senate’s Republican majority whip who leads the Tax and Fiscal Policy Committee. “It would be possible that we would authorize the administration to evaluate that option.”

The cautious approach stems, in part, from lawmakers’ desire to explore how a bond issue might jibe with constitutional restrictions on debt, and how one might affect the state’s credit rating.

Adding to the lack of urgency is President Obama’s announcement this month that he’ll push to suspend interest and principal payments on the debt for two years, a move that would require approval by Congress.

Overhauling unemployment

Indiana officials are mulling the option of issuing bonds at the same time they’re grappling with a larger overhaul of the state’s unemployment insurance system.

A decade ago, the state’s unemployment trust, the fund that supplies unemployment benefits, had a $1.6 billion surplus. But in the ensuing years, Indiana paid out more in benefits than it took in, eating up the surplus and then some. The deficits forced the state to borrow from the federal government to pay unemployment benefits.

Businesses pay state taxes—a percentage based on their layoff histories—to fill the state fund.

In 2009, the Legislature passed a tax hike that boosted premiums.

The increase, which went into effect this year, would raise businesses’ payments from $555 million last year to $866 million this year. Those bills are due at the end of the first quarter, but the Legislature is taking quick action on a measure that would reduce the bills.

The overhaul legislation—House Bill 1450, which is separate from the bonding bill—would reduce the premium increase to $723 million while also trimming benefits about 25 percent.

That bill has passed the Indiana House and is moving to the Senate, and Republican lawmakers and members of Gov. Mitch Daniels’ administration have made it clear that, for now, passing it takes precedence over considering bonding.

“Our focus is on passing HB 1450, which addresses both the structural imbalance [in payments and benefits] and the outstanding loan owed by employers and employees to the federal trust fund,” Chris Ruhl, the state’s management and budget director, said in an e-mail.

Deep in debt

Indiana is not alone in its debt load. Thirty-one states owe the federal government $42 billion for the unemployment insurance payments.

If the state doesn’t opt for bonding, it would begin repaying its debt with increased federal unemployment insurance taxes—a system set up by the federal government.

In addition to the state taxes, businesses pay the federal taxes but typically get heavy tax credits to offset that expense.

When states are in debt to the federal government, though, they lose out on tax credits by about 0.3 percent per year. The higher payments that result effectively become principal payments on the debt.

For Indiana businesses, that payment amounts to $60 million this year, according to the Department of Workforce Development.

Next year, the payments would increase to $118 million and would jump to $176 million in 2013.

Once the state starts taking more taxes into the unemployment insurance fund than it pays out in benefits, it stops losing the credits and its principal payments freeze.

So if Indiana achieves that balance in 2013, the annual principal payments would be $176 million. If the state achieves it by 2014, the payments would be $235 million.

On top of that, the state must pay interest starting at $80 million this year and decreasing each year as the principal shrinks. The debt would be paid off by 2020.

Bonding for the debt could bring some financial advantages over that arrangement, some lawmakers and financial experts say.

Depending on the status of the municipal bond market, which recently has seen a spike in interest rates because of shaky investor confidence, the state could lock in rates lower than the roughly 4 percent the federal government is charging.

Texas, for example, secured a 3.02-percent rate for two issues of 10-year bonds it sold in November and December.

Dwight Burns, executive director of the Texas Public Finance Authority, estimates that will save the state about $100 million.

Another possible advantage would be stretching out the payment period longer, which would decrease principal payments. But too long a term would add to the interest costs.

Tallian would like to see the savings used to pay unemployed workers and effectively undo the benefit cut mandated in HB 1450. But that would require separate legislation.

“It’s less painful on employers,” Tallian said, “and it’s also less painful on the unemployed because it means we don’t have to reduce benefits as much as their program is suggesting.”

Concerns raised

But for all the potential benefits, there are plenty of possible drawbacks. First, there’s a question about whether the state has legal authority to pursue the bonding.

The state only can issue debt for certain reasons under its constitution.

The Indiana Supreme Court has ruled constitutional state laws giving quasi-governmental authorities the ability to issue debt for projects, such as roads and office buildings, which the authorities leased to the state.

But because this would involve issuing debt not attached to an asset, it could require a separate court ruling before investors would be willing to purchase the bonds.

“We’re probably going to need to take a wait-and-see approach on what Congress does,” said Kevin Brinegar, president of the Indiana Chamber of Commerce. “I think it would be very difficult to move forward with this kind of uncertainty.”

For example, if the state went ahead with bonding now and the Obama proposal cleared Congress, Indiana could be stuck paying interest while other states weren’t.

Some experts also question how much savings states can realize by bonding. There are costs, for instance, associated with issuing the bonds that there aren’t with paying the federal government. And if the economy rebounds and the state can pay off the bonds early, it can be pricey to do that.

“It’s more complicated than just comparing interest rates,” said Wayne Vroman, an economist who specializes in unemployment insurance with the Washington, D.C.-based Urban Institute. “I can foresee circumstances where, with a very robust recovery and certain call features, you end up paying more,” though he added that wouldn’t be the norm.

Lawmakers will decide in the next few weeks whether Tallian’s bill will get a hearing or whether they will add a similar proposal to an existing bill.•